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Why EchoStar Corp (SATS) Stock is a Compelling Investment Case

Alex Smith
·7 min read

Steel City Capital recently released its Q3 2020 Investor Letter, a copy of which you can download here. During the third quarter of 2020, the fund returned 1.6% net of fees, while the S&P 500 Index was up 8.5%. You should check out Steel City Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.

In the said letter, Steel City Capital highlighted a few stocks and EchoStar Corp (NASDAQ:SATS) is one of them. EchoStar Corp (NASDAQ:SATS) is a provider of satellite communication and Internet services. Year-to-date, EchoStar Corp (NASDAQ:SATS) stock lost 44% and on October 27th it had a closing price of $24.27. Here is what Steel City Capital said:

"EchoStar (Long): While the Partnership’s investment in EchoStar (SATS) is not new, it has not previously been discussed in any detail. The company’s business is very simple – it derives the vast majority of its revenue from the sale of satellite-based broadband internet services to consumers and enterprises across the Americas. As of 6/30/2020, SATS had 1.5 million subscribers, of which 1.2 million are located in the U.S. To a lesser extent, the company generates revenue from the sale of equipment to government and commercial customers.

The average consumer is unlikely to be familiar with SATS offering. While more than 100 million U.S. households have broadband internet access, EchoStar and its main competitor, ViaSat, only serve a combined 1.8 million subscribers. Most American households rely on terrestrial service from cable or fiber. The small minority of households that rely on satellite connectivity do so because it is too costly to run a terrestrial line to their location. These households tend to be located in geographies with very limited population density. Specifically, more than half of SATS consumer subscribers are located in areas with five or fewer houses per square kilometer. In areas like this, it just doesn’t make sense for the local cable company to run a line to the house – they’ll never earn an adequate return on their investment.

SATS is currently valued at ~3.5x EV/EBITDA (MRQ annualized) and has reasonable growth prospects ahead of it. Specifically, the company will launch its Jupiter 3 satellite in the second half of 2021, resulting in a combination of additional subscribers and the availability of higher speed and capacity for existing customers. The new satellite should begin contributing to profitability sometime in 2022. In addition to its core satellite business, the company owns a grab bag of other assets whose value could be monetized in the future. The most interesting are the S-Band spectrum licenses being used to develop new commercial service offerings (i.e. Internet of Things).

At 3.5x EV/EBITDA, SATS valuation is an outlier in the satellite communication industry. Its closest North American peer – ViaSat – currently trades at 8.0x EV/EBITDA, consistent with its historical premium. The reasons for this premium confound me – SATS is the clear leader in North America (1.2 million subs vs. 600,000 subs) and has far less exposure to the in-flight connectivity business which has been battered by the pandemic. As another point of reference, a consortium of private equity investors acquired European-based Inmarsat in 2019 at an implied EV/EBITDA multiple of ~9.0x.

SATS is also an outlier with respect to the strength of its balance sheet. The company carries no net debt, with its $2.4 billion cash balance completely offsetting outstanding borrowings. Comparatively, ViaSat’s net leverage sits around 3.75x. It is utterly insane that EchoStar’s lower quality competitor carries leverage at a level fully in excess of EchoStar’s total valuation.

In the absence of accretive investment opportunities, the company could simply repay debt, reducing its interest burden by $160 million annually. With current run-rate EBITDA of $660 million and maintenance capital expenditures in the realm of $400 million, SATS is poised to generate in excess of $250 million of annual cash flow if it does nothing else but repay its outstanding debt. And as a reminder, EBITDA should begin to grow in 2022, following the launch of the Jupiter 3 satellite. At today’s market capitalization of ~$2.4 billion, SATS offers a compelling free cash flow yield slightly in excess of 10%. Considering the company’s leading market position in an effective duopoly, high barriers to entry in the markets it serves (low density rural areas), good prospects for growth, and recurring revenue streams, SATS is a compelling bargain in today’s low interest rate world.

The most prominent area of pushback that I run into with SATS is the competitive threat from Low Earth Orbit (LEO) satellites. It’s a hard topic to address with brevity or certainty, but I’ll highlight some of my thoughts. There’s a long list of hurdles that LEOs must overcome before establishing their operational and financial viability. For example, there doesn’t yet exist economically viable antenna technology that would support widespread residential adoption. Second, only a small portion of the nameplate capacity of a LEO system will be saleable, which should support the competitiveness of next generation geosynchronous (GEO) satellites. In order to maximize saleable capacity, LEO operators will need to target customers outside of rural communities (EchoStar’s bread and butter). Competing with the terrestrial networks that serve more densely populated areas won’t be easy. And then there is the issue of building necessary ground infrastructure. In total, such an endeavor will take billions of dollars over a multi-year period. None of this is to say it can’t be done. Two of the leading projects are being spearheaded by the world’s best known and most deep-pocketed entrepreneurs: Starlink (SpaceX/Elon Musk) and Project Kuiper (Amazon/Jeff Bezos). But I do believe reports of the pending death of GEO satellites are greatly exaggerated."

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In Q2 2020, the number of bullish hedge fund positions on EchoStar Corp (NASDAQ:SATS) stock increased by about 21% from the previous quarter (see the chart here), so a number of other hedge fund managers believe in EchoStar's growth potential. Our calculations showed that EchoStar Corp (NASDAQ:SATS) isn't ranked among the 30 most popular stocks among hedge funds.

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Video: Top 5 Stocks Among Hedge Funds

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Disclosure: None. This article is originally published at Insider Monkey.